The comment period on the Federal Reserve Boards’ proposed rules on “Debit Card Interchange Fees and Routing” (based on the Durbin Amendment) is coming to a close in the next few weeks. A number of comments have been filed, and we’ve taken a look at a number of them. Several stand out for their detailed analysis of the potential impact of enforcement of the proposed rules.

The Federal Reserve Board is requesting comment on two alternative interchange fee standards that would apply to all covered issuers: one based on each issuer’s costs, with a safe harbor (initially set at 7 cents per transaction) and a cap (initially set at 12 cents per transaction); and the other a stand-alone cap (initially set at 12 cents per transaction). Under both alternatives, circumvention or evasion of the interchange fee limitations would be prohibited. The Federal Reserve Board also is requesting comment on possible frameworks for an adjustment to the interchange fees to reflect certain issuer costs associated with fraud prevention.

Two detailed analyses of the proposed rules were filed that deserve further look – one by Joshua R. Floum, the General Counsel of Visa (NYSE:V), another by the law firm of Morrison & Foerster (aka “MoFo”). MoFo represents a number of financial services companies and banks.

Both submissions avoid discussions of whether the rules should have been proposed in the first place, and provide detailed analyses of the options proposed by the Board.

For example, the comments from Visa clearly set forth practical issues with some of the proposed options, while still providing suggestions regarding which of the options are preferred.

Visa points out some operational challenges that may not have been considered by the Board, including challenges relating to HSA cards:

Additionally, it is also worth not ing that the exclusivity and routing provisions raise operational issues with regard to an identified subset of debit cards. Specifically, although Section 920 includes exemptions or exclusions to the debit interchange provisions for government programs and certain prepaid cards, these apply only with respect to subsection (a) and not also to subsection (b). However, certain debit card product types or payment technologies may inherently not support multiple routing options. For exampl e, Flexible Spending Account (“FSA”) and Health Reimbursement Arrangement ( “HRA”) cards require functionality that identifies qualifying health care expenses versus non-qualifying expenses in order to comply with federal tax laws governing use of these cards with tax-favored healthcare spending accounts. Visa, other payment ne tworks, merchants and othe rs we re required by IRS Notice 2007-02 to develop Inventory Information Approval System (“HAS”) standards for facilitating such identification of transactions. We understand that PIN debit networks generally have not developed systems that facilitate such transactions, nor have merchants incurred the additional expense of upgr ading their terminals to support HAS for PIN debit transactions. page 6. In addition, cash access is not permitted on such cards. Therefore, issuers issue FSA/HRA cards without PIN debit functionality (i.e., signature only), inherently restricting the potential routing of transactions on such cards. Certain types of government social benefit program cards (like low- income housing assistance) may be expected to have similar restrictions, such as no cash access or limitations on usage to specific merchant category codes.

Other operational limitations are associated with gift cards:

Similarly, gift cards and other non-reloadable prepaid cards, although not exempt from Section 920(a), typically do not have PIN functionality. This limitation on PIN functionality is due in part to anti-money laundering concerns with anonymous access to cash. In addition, there are practical reasons for this limitation, including operational challenges of delivering a secure PIN to an unidentified purchaser. Because prepaid card programs are typically higher cost and lower ma rgin, issuers may simply reduce or discontinue rather than modify such programs to provide for another network, limiting the availability of products to consumers.

Read the full Visa comment submission here. It paints a picture that debit interchange regulation has a broader impact than Durbin may have originally contemplated.

The submission by MoFo is also detailed and should be helpful to the Federal Reserve Board.

MoFo focuses on the topic of issuer costs, and the financial data underlying the adoption of the rules. MoFo states:

We have been conducting a data collection effort on issuer costs that builds on the Board’s survey. This effort is ongoing, but we believe that we are developing a compilation of accurate data that is reasonably comparable across institutions. Our efforts to date show that there are significant differences among issuer cost data. In many cases, the differences in our cost data appear to be a function of different interpretations of survey questions. Nevertheless, when these differences are accounted for, there still appears to be significant variability among issuers. There are many factors that contribute to cost variability some of which include portfolio volume and mix. This wide variability of costs suggests that the rate structure that the Board adopts could have differing effects across the spectrum of financial institutions. In addition, in reviewing 2009 issuer data, it has also become apparent that these data cannot provide an accurate picture going forward because of other regulatory changes, including the potential exclusivity and routing requirements under Section 920(b) of the EFTA, which may increase issuer costs.

MoFo suggests that “further analysis and refinement of the data that we are our developing and our evolving understanding of likely market dynamics may lead to additional or different views on the implementation of Section 920.”

Clearly, the adoption of debit interchange rules involves complex issues, many of which may not have been considered when the Durbin Amendment was passed, and when the Board promulgated the proposed rules.

The Federal Reserve Board is requesting comment on two alternative interchange fee standards that would apply to all covered issuers: one based on each issuer's costs, with a safe harbor (initially set at 7 cents per transaction) and a cap (initially set at 12 cents per transaction); and the other a stand-alone cap (initially set at 12 cents per transaction). Under both alternatives, circumvention or evasion of the interchange fee limitations would be prohibited. The Federal Reserve Board also is requesting comment on possible frameworks for an adjustment to the interchange fees to reflect certain issuer costs associated with fraud prevention.

Two detailed analyses of the proposed rules were filed that deserve further look - one by Joshua R. Floum, the General Counsel of Visa (NYSE:V), another by the law firm of Morrison & Foerster (aka "MoFo"). MoFo represents a number of financial services companies and banks.

Both submissions avoid discussions of whether the rules should have been proposed in the first place, and provide detailed analyses of the options proposed by the Board.

For example, the comments from Visa clearly set forth practical issues with some of the proposed options, while still providing suggestions regarding which of the options are preferred.

Visa points out some operational challenges that may not have been considered by the Board, including challenges relating to HSA cards:

Additionally, it is also worth not ing that the exclusivity and routing provisions raise operational issues with regard to an identified subset of debit cards. Specifically, although Section 920 includes exemptions or exclusions to the debit interchange provisions for government programs and certain prepaid cards, these apply only with respect to subsection (a) and not also to subsection (b). However, certain debit card product types or payment technologies may inherently not support multiple routing options. For exampl e, Flexible Spending Account ("FSA") and Health Reimbursement Arrangement ( "HRA") cards require functionality that identifies qualifying health care expenses versus non-qualifying expenses in order to comply with federal tax laws governing use of these cards with tax-favored healthcare spending accounts. Visa, other payment ne tworks, merchants and othe rs we re required by IRS Notice 2007-02 to develop Inventory Information Approval System ("HAS") standards for facilitating such identification of transactions. We understand that PIN debit networks generally have not developed systems that facilitate such transactions, nor have merchants incurred the additional expense of upgr ading their terminals to support HAS for PIN debit transactions. page 6. In addition, cash access is not permitted on such cards. Therefore, issuers issue FSA/HRA cards without PIN debit functionality (i.e., signature only), inherently restricting the potential routing of transactions on such cards. Certain types of government social benefit program cards (like low- income housing assistance) may be expected to have similar restrictions, such as no cash access or limitations on usage to specific merchant category codes.

Other operational limitations are associated with gift cards:

Similarly, gift cards and other non-reloadable prepaid cards, although not exempt from Section 920(a), typically do not have PIN functionality. This limitation on PIN functionality is due in part to anti-money laundering concerns with anonymous access to cash. In addition, there are practical reasons for this limitation, including operational challenges of delivering a secure PIN to an unidentified purchaser. Because prepaid card programs are typically higher cost and lower ma rgin, issuers may simply reduce or discontinue rather than modify such programs to provide for another network, limiting the availability of products to consumers.

Read the full Visa comment submission here. It paints a picture that debit interchange regulation has a broader impact than Durbin may have originally contemplated.

The submission by MoFo is also detailed and should be helpful to the Federal Reserve Board.

MoFo focuses on the topic of issuer costs, and the financial data underlying the adoption of the rules. MoFo states:

We have been conducting a data collection effort on issuer costs that builds on the Board's survey. This effort is ongoing, but we believe that we are developing a compilation of accurate data that is reasonably comparable across institutions. Our efforts to date show that there are significant differences among issuer cost data. In many cases, the differences in our cost data appear to be a function of different interpretations of survey questions. Nevertheless, when these differences are accounted for, there still appears to be significant variability among issuers. There are many factors that contribute to cost variability some of which include portfolio volume and mix. This wide variability of costs suggests that the rate structure that the Board adopts could have differing effects across the spectrum of financial institutions. In addition, in reviewing 2009 issuer data, it has also become apparent that these data cannot provide an accurate picture going forward because of other regulatory changes, including the potential exclusivity and routing requirements under Section 920(b) of the EFTA, which may increase issuer costs.

MoFo suggests that "further analysis and refinement of the data that we are our developing and our evolving understanding of likely market dynamics may lead to additional or different views on the implementation of Section 920."

Clearly, the adoption of debit interchange rules involves complex issues, many of which may not have been considered when the Durbin Amendment was passed, and when the Board promulgated the proposed rules.